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Marshalling leads to equitable mortgages being worth more than the paper they are written on

Through a process known as “marshalling”, the High Court has ordered that suppliers to failed company Starplus Homes Ltd (In Liquidation) (Starplus) who have unregistered equitable mortgages can share in a surplus of proceeds of sale with a registered second mortgagee.

The judgment sends a strong encouragement to suppliers to include an equitable mortgage in their terms of trade. Click here for a copy of the judgement.

The case, Adams & Buchanan (as liquidators of Starplus Homes Ltd (In liquidation)) v Sun & Ors [2014] NZHC 912*, concerned the failed property development company, Starplus. ASAP Finance Ltd (ASAP) was the primary funder of Starplus, and had taken mortgages over 20 properties. When Starplus defaulted on its loans, ASAP enforced its mortgages over the 20 properties. ASAP’s enforcement of the mortgages resulted in a surplus of $1.7 million.

There were four parties competing for the $1.7 million surplus, namely:

Mr Sun, who was a registered second ranking mortgagee of the last two properties sold (the Manukau properties); and

Magsons Hardware Ltd, Hamilton Hardware Retail Ltd, United Timber Merchants Ltd, and RD 1 Ltd, all of which had supplied goods to Starplus for the construction (the Suppliers).

The first issue was whether the terms of trade between Starplus and each of the Suppliers were sufficient to charge properties acquired by Starplus after the terms were entered into with equitable mortgages in favour of each Supplier.

Equitable mortgages can be useful to building suppliers. This is because the supplied goods invariably become part of a building. At that point, legally, the supplied goods are “affixed” to the land and any personal property security interest that the supplier has in the supplied goods falls away. An equitable mortgage gives the supplier security over the land itself.

In Starplus, the Court held that Magsons and Hamilton Hardware, who had each signed Starplus’ general terms, were granted equitable mortgages despite that later agreements had been entered into which varied the terms of trade with Starplus. Additionally, the Court held that United Timber’s and RD 1’s standard terms, which Starplus had signed, also gave equitable mortgages to United Timber and RD 1.

In terms of priority, Mr Sun’s registered mortgage security prevailed over the equitable mortgages of the Suppliers. Under s185 of the Property Law Act 2007, Mr Sun was therefore entitled to the surplus ahead of the Suppliers.

However, the Suppliers raised the argument of marshalling by contending that the order in which ASAP sold the mortgaged properties results in a windfall for Mr Sun. If ASAP sold the Manukau properties first, the whole of the proceeds of those sales would have gone to ASAP, and Mr Sun would be left with nothing. In those circumstances, the Suppliers would have received some of the surplus instead of Mr Sun.

Under marshalling, the Court can allocate the surplus left over by ASAP as a “senior creditor” to Mr Sun and the Suppliers as “junior creditors” in a way that is equitable to the junior creditors. Importantly, this allocation is made despite that a junior creditor’s security (i.e. Mr Sun’s registered second mortgage) ordinarily prevails over other junior creditors’ security (i.e. the Suppliers’ equitable mortgages) under the Property Law Act.

The Court found that ASAP’s arbitrary order of selling the properties had resulted in an inequitable result and ordered that the Suppliers could share in the surplus. In reaching its decision, the Court noted rather ironically that had the Manukau properties been sold first, Mr Sun would likely be raising the marshalling argument to obtain a share of the surplus. This undoubtedly was taken into account in the Court’s decision.

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